ANNUAL REPORT TO CONGRESS 2020 FROM THE DIRECTOR This year brought a financial environment of rapid and periodically unpredictable change. Unlike previous Annual Reports from the Office of Financial Research (OFR), this year’s report is unique in that it was written in the wake of a material threat to financial stability. Economic indicators on the eve of the global pandemic showed little if any concern about a slowdown, let alone a sharp but short economic contraction. For example, the U.S. civilian unemployment rate for February 2020 dropped to a 50-year low of 3.5 percent. It then spiked to 14.7 percent just two months later. Over the turbulent months since the start of the COVID-19 pandemic, our Office’s mission has never been more clear or important. As COVID-19-related disruptions evolve, our Office’s data and research products will continue to provide timely indicators of financial stress for the Financial Stability Oversight Council (FSOC) and its members. Following my confirmation in 2019, OFR prioritized an all-staff effort to dutifully fulfill our Dodd-Frank Act responsibilities. While our mission is simple, it FROM THE DIRECTOR i is essential — that is, to further financial stability through the analysis of informative financial data, as well as the advancement of data standards and products, principally in support of FSOC and its members. Indeed, throughout the turbulent months that began in February of this year, the value that our Office has provided to FSOC and its members has increased and deepened considerably from already consequential levels. Reviewing my first full year as Director, I am proud of the important work that members of our staff have accomplished, and confident that our path forward will continue to find OFR leading the development of advanced research insights and data services. OFR monitors and analyzes both potential and realized stressors in financial markets and institutions, with the objective of clarifying the cause and extent of any associated vulnerabilities. Our Office plays a complementary role in supporting financial stability, which is always important, and especially so during the natural disaster triggered by COVID-19. Throughout the serious difficulties that COVID-19 brought to our health, economic, and financial sectors, our Office continued to build on its important work. For example, over a decade ago, the Dodd-Frank Act established a legislative mandate for OFR to build a Financial Instrument Reference Database (FIRD), but that mandate lay dormant until ii OFR ANNUAL REPORT TO CONGRESS 2020 now. This year, our Office made significant progress toward making this mandate a reality. Our team continues to make valuable contributions as members of FSOC’s Systemic Risk and Data Committees, while continuing to collaborate with individual member offices throughout. OFR’s Data Center began releasing cleared repo data and launched our Office’s Short-term Funding Monitor — an interactive tool that reliably delivers a more complete view of short-term funding markets. And furthermore, our Office added important enhancements to our Bank Systemic Risk Monitor, which tracks systemic risks that interconnections among the largest banks can create. In addition, our Office’s international leadership within the Legal Entity Identifier (LEI) continues to further the adoption and integrity of data standards that bring greater transparency and efficiency to financial markets worldwide. Contributions to our annual report have come from every part of our Office. I am proud of this good work and whole-team effort, and even more so during the fallout from a global pandemic and sharp but short economic recession. I am grateful for the integrity that our staff members bring to our Office each and every day. Without it, we cannot do our best work. With it, we will FROM THE DIRECTOR iii continually strengthen our Office’s support of FSOC and its members by building on our Office’s organizational excellence, and furthering our culture of accountability and professionalism at every level. Finally, let’s always remember why we engage this mission — because when and where financial stability is compromised, economic opportunities go missing throughout our society. And the impact can be especially acute for low- and moderate-income households that may have trouble weathering emergencies, lack opportunities for economic mobility, or face high hurdles to improve life chances for children. As we turn to further recovery, OFR will continue to fulfill its mission by strengthening financial stability, and ultimately economic opportunity. Dino Falaschetti Director, Office of Financial Research iv OFR ANNUAL REPORT TO CONGRESS 2020 TABLE OF CONTENTS FROM THE DIRECTOR i SUMMARY: OFR 2020 ANNUAL REPORT TO CONGRESS 3 Assessing Financial Risks in a Turbulent Year 4 Assessing Financial Risks and Uncertainty 5 Exploration of Information Markets 6 The OFR’s Performance 7 PART ONE: ASSESSING FINANCIAL RISKS IN A TURBULENT YEAR 11 COVID-19 and the Financial Crisis of 2020 11 Financial Stability and Economic Opportunity 21 Why Is Financial Stability Important? 21 How Does the COVID-19 Pandemic Threaten that Stability? 21 How Have Previous Crises Threatened Financial Stability and Economic Opportunity? 22 How Can Financial Stability Be Maintained? 24 PART TWO: ASSESSING FINANCIAL RISKS AND UNCERTAINTY 29 Summary of Risks 29 Macroeconomic Risk 30 U.S. Economic Conditions 31 Global Economic Conditions 34 Policy Responses 36 Uncertainty Prevails 37 Credit Risk 38 Nonfinancial Corporate Credit 39 Household Credit 53 Residential Real Estate 56 State and Local Debt 60 Pension Funds 62 Foreign Government Debt 65 Market Risk 68 Stock Markets 68 Derivatives Markets 69 Bond Markets 70 Liquidity and Funding Risk 73 Financial Institutions 73 Financial Markets 77 Leverage in the Financial System 84 Banks 84 Insurance Companies 85 Hedge Funds 85 Financial Firm Insolvency Risk and Potential Contagion 89 Financial Firm Insolvency Risk 89 Contagion Risk Within the Financial System 94 Cybersecurity Risk 98 Financial Services Sector Use of Information Technology 99 Cyber Contagion and Concentration Risks 100 Emerging Quantum Computing Risk 101 Improving Financial System Cybersecurity 102 Additional Risks 102 Natural Disasters 102 Transition from LIBOR to Alternative Reference Rates 103 U.K. Exit from the European Union 105 PART THREE: EXPLORATION OF INFORMATION MARKETS 109 The Roots of Systemic Risk 110 How Information Markets Might Complement Systemic Risk Management 112 PART FOUR: THE OFR’S PERFORMANCE 119 A Year of Mission Focus 119 A New Strategic Plan 119 Steady Progress 119 International Leadership in Cross-border Financial Data Standards 119 Greater Adoption of the Legal Entity Identifier (LEI) by Governments and the Private Sector 119 Improved LEI Data Quality 120 Establishment of New Cross-border Financial Data Standards 120 Data Products and Innovations 121 U.S. Repo Markets Data Release and the Short-term Funding Monitor (STFM) 122 Financial Stress Index (FSI) 124 U.S. Money Market Fund (MMF) Monitor 124 Interagency Data Inventory 124 Bank Systemic Risk Monitor (BSRM) 124 Financial Instrument Reference Database (FIRD) 125 Collaboration 126 Support for the Financial Stability Oversight Council and Its Members 126 Financial Research Advisory Committee (FRAC) 126 Standards Bodies and Public Forums 126 Conferences Cosponsored 128 Information Technology (IT) 128 Cloud Resources and Increased Capabilities 128 Remote Capabilities 128 Data Collection and Management 128 Data and Information Security 129 OFR Organization 129 Growth Management 130 Budget 131 GLOSSARY 135 ENDNOTES 153 BIBLIOGRAPHY 167 All data cited in this report are as of Sept. 30, 2020, unless otherwise noted. SUMMARY: OFR 2020 ANNUAL REPORT TO CONGRESS SUMMARY: OFR 2020 ANNUAL REPORT TO CONGRESS With this report, the Office of Financial Research (OFR) presents its assessment of the state of the U.S. financial system, as required by the Dodd- Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act). The 2020 Annual Report to Congress fulfills OFR’s requirement to submit a report to Congress within 120 days of the close of the fiscal year (FY). All data cited in this report are as of Sept. 30, 2020, unless otherwise noted. This report also reflects the OFR’s duty to inform policymakers, regulators, market participants, and the American public about its work to monitor, investigate, and report on changes in systemwide financial stability risk levels and patterns. The OFR’s efforts support sound risk management for the entire financial system. For FY 2020, the report is organized into four main parts: Assessing Financial 1 Risks in a Turbulent Year Assessing Financial 2 Risks and Uncertainty Exploration of 3 Information Markets The OFR’s 4 Performance SUMMARY 3 Assessing Financial Risks 1 in a Turbulent Year It has been a decade since economic, and financial the OFR was established effects. During March, the and this report is presented medical crisis prompted U.S. during a time of financial state and local government of gross domestic product and economic uncertainty decisions to declare stay- at the end of FY 2020 from that is a first for the Office. at-home orders and order 79 percent at the end of FY The OFR’s data, research, the shutdown of many 2019. and monitoring expertise businesses. The pandemic was well-utilized this year and efforts to contain the As this report goes to and played an important health threat drastically press, America’s economy role in identifying and curtailed economic activity has climbed rapidly back understanding how and severely stressed from the short but steep stresses within the U.S. financial markets. On March COVID-19 recession. And financial system during 9, 12, and 16, the Dow while our economy retraces March 2020 interacted with Jones Industrial Average, its way back to trends vulnerabilities identified in for example, experienced that characterized the previous years. Government some of the worst price pre-pandemic economy, financial system downturns in its history.